Nonprofit Accounting is Different: Here’s How
Carolyn, the executive director of an educational nonprofit, was thrilled, after a long search, to welcome two new members to her charity’s board of directors — both from the for-profit business world. However, she was a little concerned about a few of the comments and questions that arose in their first board meeting. It was clear the two new directors didn’t quite grasp the differences between nonprofit and for-profit financial reporting.
You may have encountered the same issue with new board or staff members more accustomed to profits and shareholders than restricted gifts and donors. Here’s an easy way to explain how the two sectors differ.
Profits vs. purpose
As the term suggests, for-profit companies are driven by the desire to maximize profits for their owners. Nonprofits, on the other hand, are generally motivated by a charitable or other tax-exempt purpose. From a financial perspective, they need adequate revenue to enable them to fulfill their mission now and into the future.
Their respective financial statements reflect this difference. For-profits report mainly on profitability and increasing assets, which correlate with future dividends and return on investment to owners and shareholders. Nonprofits report to funders, board members and the community on their financial position, the amounts received or promised from various funding sources, and how funds are used for programs and supporting services.
Statements reflect differences
For-profits and nonprofits use different financial statements for their reporting of assets and liabilities. For-profit companies prepare a balance sheet that lists the owner’s or shareholders’ equity, which is based on the company’s assets, liabilities and accumulated profits or losses. The equity determines the value of a company’s common and preferred stock.
Nonprofits, which have no owners, prepare a statement of financial position, which also looks at assets, liabilities and prior earnings. According to recently revised accounting standards (effective for fiscal years beginning after December 15, 2017), resulting net assets should be classified either as those without donor restrictions or those with donor restrictions.
Another key difference: Nonprofits are generally more focused on transparency than are for-profit companies. Thus, their financial statements and footnotes include disclosures about the:
- Nature and amount of donor-imposed restrictions on net assets,
- Amount, purpose and type of board designations of net assets, and
- Availability and liquidity of assets to cover operations in the coming year.
For example, if a nonprofit has underwater endowments, it must disclose the fair value of the funds, the original endowment gift amount required by the donor’s stipulations and the amount by which the endowment funds are deficient.
For-profits and nonprofits also take different reporting approaches to revenues and expenses. For-profits produce an income statement (also known as a profit and loss statement), listing their revenues, gains, expenses and losses to evaluate financial performance.
Nonprofits often rely on grants and donations in addition to fee-for-service income. So they prepare a statement of activities, which lists all revenue (less expenses) and classifies the impact on each net asset class. Also, they’re required to categorize expenses by both nature (meaning categories such as salaries and wages, rent, employee benefits and utilities) and function (various program services and supporting activities). This information must be expressed in a grid format that shows the amount of each natural category spent on each function.
Despite these different approaches, for-profit and nonprofit organizations share some financial reporting similarities. Both must carefully track all of their transactions; maintain supporting documentation; and produce accurate, timely financial statements. Both organization types use financial statements to manage their businesses and make financial decisions. And both can benefit from the services of qualified financial professionals with sector-specific knowledge.
Training is important
Because your board is ultimately responsible for your organization’s fiscal health, its members must understand how nonprofit accounting works. If they come to you from the for-profit sector, make sure you provide them with training so they can succeed in their new job.